Tuesday, March 8, 2016

Electronic Signatures: OK to Use?

This blog post focuses on the use and validity of electronic signatures. We will first investigate what constitutes an "electronic signature", we will then discuss the validity and enforceability of electronic signatures, and finally, we will talk about the risk involved with unauthorized use of electronic signatures and how to minimize it.

What are "electronic signatures"?

The federal law titled the Electronic Signatures in Global and National Commerce Act (also called ESIGN Act) defines an electronic signature as “an electronic sound, symbol, or process attached to or logically associated with an electronic record and executed or adopted by a person with intent to sign the record.” This broad definition allows flexibility in what may be considered an electronic signature and permits individuals and businesses to use different types of technologies and methods to create valid and legal electronic signatures. Examples of electronic signatures include:
  • Keyboard characters entered in a specific order, such as a PIN number or a password;
  • Clicking a button or checking a box to agree to the terms shown on a screen, called a “click wrap” system;
  • Signing an electronic keypad; 
  • A graphical representation, image or a scan of a handwritten signature; or
  • Agreeing to terms described in an email that would suggest acceptance of terms in the email.
Another type of electronic signature is a digital signature, which uses technology called a Public Key Infrastructure (PKI) to make a unique pattern that is coded into an electronic document. This acts as an identifier that is unique to the signer to guarantee identity, intent, and integrity of the document for verification purposes. Because of this technology, the digital signature is more secure than the traditional types of electronic signatures.

In the current environment where many communicate through email, the laws of electronic signatures also apply to email. A person can make enforceable agreements through email if the email contains the important and material terms of the agreement and clearly shows that both parties intended to agree to the terms set forth in the email. In this case, the electronic signature can come in the form of the signer’s name at the end of the email, though courts have found that automatic signature blocks at the end of an email are not sufficient for an electronic signature. In order to have a valid electronic signature in an email, the signature should show that the person manually entered the name with the intent to agree and sign. Suggested signatures in an email include:
  • Preceding or including a unique character in addition to the signer’s name, such as “/s/”;
  • Using a unique method of entering the signer’s name, such a cursive font or script; or
  • Using a graphical representation or image of the signer’s name.
Are “electronic signatures” valid?

The ESIGN Act protects the validity and enforceability of signatures made electronically. According to the ESIGN Act:
  1. a signature, contract, or other record relating to such transaction may not be denied legal effect, validity, or enforceability solely because it is in electronic form; and 
  2. a contract relating to such transaction may not be denied legal effect, validity, or enforceability solely because an electronic signature or electronic record was used in its formation. 
The ESIGN Act does not apply to certain transactions, which include:
  • Wills, trusts, and codicils;
  • Family matters, such as adoption and divorce; 
  • Most of the transactions covered by the Uniform Commercial Code; however, other statutes that relate to transactions under the Uniform Commercial Code allow electronic signatures for transactions that are exempt from the ESIGN Act; 
  • Notices of default, foreclosure or eviction; 
  • Termination of utility services; 
  • Termination of health or life insurance; 
  • Product recalls; and 
  • Documents related to the transportation of hazardous materials. 
The ESIGN Act does not require a person to use or accept electronic signatures if the parties prefer traditional methods of signatures. This means that there must be consent from the parties to enter into the transaction through electronic means. Consent can be explicit (such as a clear indication in writing that the parties intend to enter into the transaction through electronic methods) or implicit (such as a signer frequently accessing a website or repeatedly communicating through email and the terms of the agreement are set forth in the email – a one-time email may not be sufficient).

Unauthorized use of electronic signatures

Now, let’s discuss the legal consequences of somebody else using a person's electronic signature without authorization.  There is a risk that such person will be held liable even if hedid not authorize the use of the image containing his electronic signature.  However, there are ways to minimize this risk.  Remember that the ESIGN Act requires the signer to have “intent to sign the record.”  So, whoever signs electronically, should be able to confirm his identity and the “intent to sign.”  If a person's electronic signature was used without authorization, then such person should be able to prove the opposite: that it was not him who signed and that he did not have any intent to sign that particular document.  How to prove that?  Below are several suggestions:
  • Set up procedures to protect and limit access to your e-signature (PINs, passwords, restricted access);
  • Consider using a digital signature with PKI technology;
  • If an email is used, then always keep email trail that shows who had access to your e-signature; and
  • Keep records of computer systems that link computers and IP addresses to show who may have accessed the image or sent the agreement with the image.
Since the ESIGN Act requires “intent to sign the record,” any evidence that shows lack of intent helps the signer avoid liability in the event of unauthorized use of the image.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Wednesday, February 24, 2016

Winter 2016: raising funds may become more difficult for some startups

I attended several VC events in New York City recently, including Ask a VC forum on February 4, organized by DLA Piper, and the VC Summit on January 26, organized by Gotham Media.  I learned some interesting insights, which may be useful for those startup founders looking to raise capital now.

Current investment climate.  Everybody noted that the current investment climate has changed. VCs who participated in the panel discussions all agreed that the valuations have come down (some said "a bit" and others said "aggressively"), and that it now takes longer for companies to raise their first round of capital. Recent posts by Brad Feld and Mark Suster confirm that. As Mark said: "The startup industry may be “resetting,” which doesn’t mean a “crash” but rather just a resetting of valuations, timescales, winners/losers, capital sources and the relative emphasis of growth rates vs. burn rates." So, startups should perhaps re-think their valuations and allocate extra 1-2 months to raise the needed capital, stretching the capital raising efforts from 4 to about 6 months. Having said that, great startups will still get funded pretty quickly regardless of the current downturn.

How to find VCs that will fund you.  This has been talked about so much, that it is really no longer a mystery.  VCs will rarely fund companies that have emailed them at random.  VCs tend to consider only those companies that have been pre-filtered by a trusted referral source (other VCs, advisors, their portfolio companies, etc.).  VCs like to fund repeat entrepreneurs who have already successfully existed from at least one startup.  If you are not that, then you need to do your homework.  Select VCs that are likely to invest in your company (VCs that focus on your industry and  invest in seed rounds).  Read all you can about them.  Figure out which companies they've funded in the past.  Reach out to the portfolio companies founders, and see if you can get them to like you and your startup.  Then, they may introduce you to their VCs.  Also, do not despair if these introductions do not produce immediate funding results: establish connections with the VCs and keep in touch through regular updates. Funding from them may come at a later stage.

Angel investors vs VCs.  An interesting phenomenon has developed: the appearance of micro VCs (i.e., smaller venture capital firms that are focused on early stage financing).  In my experience, an average startup would first get funded up to $1 million by angel investors (wealthy, accredited individuals).  These may be family members and friends, or other accredited investors.  Angel investors don't typically get a seat on the board, or help out with industry expertise or connections (but I've seen exceptions).  Later stages of financing are typically handled by VCs.  Now, I see more VCs come in at the seed rounds, including convertible debt financings.  It is an overall positive development for the companies because VCs tend to invest in subsequent rounds as well, and have industry expertise and connections that may prove useful to the companies. Finally, VCs bring with them expertise in running a startup.  Of course, there are disadvantages as well (since VCs want board seats, there is always a danger that once they have control of the board, they may oust the founders).

How much money to raise in the seed round?  The rule of thumb seems to be: raise enough cash to last 18 months and give up 15-20% of your company in exchange.  Just remember to start your next fundraising campaign 4-6 months before you run out of money.

What are VCs looking for?  They are looking for a scalable business model.  VCs don't want beautiful power point slides or well-scripted presentations.  They want to see substance, such as a well-stated problem, the proposed solution, clear execution plan and milestones.  Also, be prepared to explain why you need this much money and how you plan to spend it.  During the presentation, the founders should be able to explain the whole business in 20 slides or less.

Finders.  Be careful about signing any agreements with finders (people who offer to make introductions to potential funding sources in exchange for a referral fee).  First, if they are not registered with the SEC, they may get themselves and your company into trouble.  I wrote about it here.  Second, VCs don't like to see their money going to pay somebody's referral fees.

In conclusion, please remember that only a small fraction of all startups gets funded by VCs at any stage of their development, and you need to prepare well for the fundraising campaign.  As for those who are not successful with the VCs: Regulation Crowdfunding, which becomes effective on May 16, 2016, will soon open more funding sources for startup companies.  More on this topic later.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Thursday, January 21, 2016

Why Companies Are Choosing to B Good: A Closer Look at Delaware Public Benefit Corporations

As of August 1, 2013, the Delaware Legislature added Subchapter XV to its Delaware General Corporation Law (“DGCL”) providing for the formation of a Public Benefit Corporation (“PBC”). As of now, 31 states (including the District of Columbia) have enacted similar statutes, with Maryland and Vermont leading the way by becoming the first states to do so in 2010.  You can check the status of benefit corporations in each state here. This blog, however, will focus only on Delaware PBCs. Delaware is home to over 1,000,000 corporations.  Approving a PBC entity structure in Delaware is an endorsement of corporate culture that aims to conduct business in a responsible and sustainable manner.

Similar to a regular corporation, a PBC is a for-profit corporation that, in addition to maximizing shareholder value, is committed to pursing a purpose that would create a public benefit. There are however key differences that set these two types of entities apart. This blog will discuss differences between the two entity structures and why this new corporate structure is so enticing to socially conscious entrepreneurs.

Formation and Purpose

In its certificate of incorporation, a PBC must identity itself as a public benefit corporation (that means that it is going to have “P.B.C.” or “PBC” at the end of the name rather than an "Inc.") and must list at least one public benefit that it intends to pursue.

Section 362 (b) of DGCL defines a public benefit as a “positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities or interests (other than stockholders in their capacities as stockholders) including, but not limited to, effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature.”

Responsibility and Reporting Requirements

Unlike in a traditional corporation, directors in a PBC must provide a biennial (once every two years) report to the shareholders describing the corporation’s promotion of the public benefit identified in its certificate of incorporation. The report has to include the objectives established by the board to promote the public benefit; the standards adopted by the board to measure the corporation's progress in promoting such public benefit; objective factual information based on those standards regarding the corporation's success in meeting its objectives; and finally an assessment of the corporation's success in meeting its objectives.

This requires taking additional corporate governance steps, including the development of clearly defined objectives and standards that can be measured and quantified in order to assess the corporation's success in meeting its public benefit goals.  

Fiduciary Duties

Directors owe fiduciary duties of care and loyalty to both the company and the shareholders. The duty of care requires directors to act in the same manner as a reasonably prudent person in their position would. The business judgment rule offers directors some protection in this category from any losses incurred under their watch as long as the decisions were made in good faith and with reasonable skill and prudence. The duty of loyalty is an affirmative duty to protect the interests of the corporation, and also an obligation to refrain from conduct which would injure the corporation and its shareholders such as self-dealing. 

A PBC's board duties are pretty much the same.  However, when making decisions, the directors are required to balance the "pecuniary interests of the stockholders, the best interests of those materially affected by the corporation's conduct, and the specific public benefit or public benefits identified in its certificate of incorporation." DGCL 365(a).

In a change of control situation, the business judgment rule standard of review applied to a regular corporation's board of directors is changed to that of enhanced scrutiny standard (remember the Unocal and Revlon decisions?) (Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985); Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. 506 A.2d 173 (Del. 1986)). At the time of a company sale or a takeover, directors are required to maximize the shareholders' value by seeking the highest price available. However, in a Delaware PBC, the board's duty to consider other constituencies and society as a whole does not go away in the context of a merger or a takeover. A Delaware PBC board cannot simply sell to the highest bidder. It needs to consider and which acquirer would be most suitable to continue furthering the corporation's public benefit purpose.

Benefit Corporation vs. B Corp Certification

Often used interchangeably, a PBC and a B corp should not be confused with one another. A PBC is a legal entity form (like an LLC or a corporation or a partnership), while a B Corp is a certification awarded by B Lab, a non-profit organization that serves the global movement of people using business as a force for good. In order to obtain the certification, the company must first become a benefit corporation in its home state. There is a strict process to become certified. Additionally, B Lab charges annual fees which are assessed on a sliding scale, starting at $500 for companies with revenues of less than $1 million to $50,000 for companies with revenues over $1 billion.  Etsy, Patagonia, Warby Parker, Plum Organics are all examples of companies that received certification as B corp companies.

Thinking of Converting?

A traditional corporation can easily be concerted to a PBC by filing an amendment to its certificate of incorporation with the DE Department of State. The amendment would require an approval of 90% of the outstanding shares of each class of stock (whether voting or nonvoting) of the corporation.  A merger or a consolidation with a domestic or foreign PBC also requires the same 90% vote.

Perhaps one of the largest recent converts from a traditional C corporation to a PBC (2015) is Kickstarter, PBC (formerly, Kickstarter, Inc.) Kickstarter, a crowdfunding platform, proudly lists their conversion on their website along with their mission statement “to help bring creative projects to life.”  Since its conversion, Kickstarter has received a lot of publicity regarding their new status and has been branded as one of the many companies that want to be apart of movement demonstrating they are not all about maximizing profits. Articles discussing their recent conversion to a benefit corporation can be found here and here.

Going Back

A two-thirds vote of the outstanding shares of each class of the PBC, whether voting or non-voting, is required to terminate the PBC status.  This makes it difficult for just one group within the corporation to decide to revert to a regular corporation status, unless supermajority of the corporation's shareholders also agree.

Is There Really a Downside?

This new entity type allows companies to legally use their resources to advance a public purpose that they believe in, while working towards increasing company revenue. How can there be a downside? Some say that small companies and start-ups choosing to register as benefit corporations may have harder time securing investors because benefit corporations may not always have the same returns as regular corporations.  However, this is changing. According to B Lab, many lead VC funds have invested into benefit corporations.  

Here is the list: Abundance Partners, Andreessen Horowitz, Baseline Ventures, Benchmark, Betaworks, Brand Foundry, Bullet Time Ventures, Capital, Freshtracks Capital, Claremont Creek Ventures, Collaborative Fund, CommonAngels Ventures, DBL Investors, Emerson Collective, First Round Capital, Forerunner Ventures, Formation|8, Founders Fund, Foundry Group, Generation Equity Investors, Good Capital, Greycroft Partners, Hallett Capital, Harrison Metal, Impact America Fund, Kapor Capital, Kortschak Investments, Learn Capital,Lighter Capital, Matrix Partners, New Enterprise Associates, New School Ventures, Omidyar Network, Pacific Community Ventures, Peterson Ventures, Prelude Ventures, Reach: New Schools Capital,Red Swan Ventures, Renewal Funds, Serious Change, SherpaVentures, Tekton Ventures,The Westly Group, Thrive Capital and Union Square Ventures.

Another disadvantage that a PBC must endure is their reporting requirement to the shareholders regarding whether or not the company is successfully working towards and fulfilling their public purpose. The good news here is that in Delaware, the reporting requirement is not as onerous as in several other states. Delaware PBCs are not required to (i) appoint a benefit director or officer; (ii) disclose the benefit report to the secretary of state; (iii) use a third party standard or assessment in connection with the report; (iv) prepare the report annually; or (v) consider the impact of every single corporate decision on a variety of stakeholders (shareholders, employees, customers, etc.).

So, being a benefit corporation may not be such a disadvantage after all.

Delaware PBC Act is flexible, and combined with the authority and weight of DGCL in general, may make a big shift in the US corporate culture towards a greater use of benefit corporations to conduct business. It just might pay to B good.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.